The study A hard turnaround for software published in the recent McKinsey Quarterly cites various reasons why the revival in software industry is difficult. Most importantly, when the tough forces unique to the sector such as product environment, financial environment and labour conditions form a vicious cycle which can lead to rapid deterioration of a software firm.
In the product market, the need for compatible technology, high switching costs and movement towards scale results in only few players surviving in the long run.
In the financial markets, the valuation of the stock prices is based on intangible assets such as employees, customer relationships and technology. During a downturn, software firms are badly affected as the financial performance will take a hit and this will lead to a lower valuation of the intangible assets. If insolvency is a prospect, then investors will hastily pull out from the firm as the residual value in physical assets is minimal.
Labour markets can also contribute to the fall. Stock options, which form a considerable part of employee conpensation, tend to lose value in a downturn and become less attractive to employees. A company beginning to fail can witness large scale attrition with the most valuable workers beginning to leave first.
The McKinsey consultants suggest the following strategy for companies in trouble. The firms should focus on the core business. During the boom phase, most companies rushed into new geographies, products and customer segments. They should now consider which of these form a part of the core.
Further investment should be made in category killers such as products which would give a 30 per cent market share. Senior managers should get feedback from customers, analysts and partners, the study says.
Cost cutting must be ruthless in non-core areas. A firm that fails to make tough decisions will a small chance to restore business to good health. Also, the trust of the financial markets must be got. Improving working capital mangement and trying to get capital infusion are some ways.
A turnaround team can be appointed and given power to act fast. They should secure the support of the leaders of the firm and work towards a turnaround.
The Indian software firmament is littered with companies in trouble. It is important that they focus on their core areas, cut costs ruthlessly and win back the trust of the financial markets and other stakeholders. Many top managers of young Indian software firms have not seen a downturn and it is important they have a good team in place, said an analyst with a domestic brokerage firm.
The study considered 814 publicly traded US firms and total returns of 492 firms that declined by over 50 per cent over a two-year period relative to the S&P Computer Software and Services Index. The 492 firms formed the base for the study.